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W.R. Grace & Co., a large chemicals company that filed for bankruptcy due to asbestos liabilities, disclosed in an SEC filing that it is the target of a federal grand jury investigation related to its vermiculite mining and processing activities in Libby, Montana. According to the company's 8-K filing with the SEC:

Grace understands that the investigation is at an advanced stage and that it is likely to be indicted during the first quarter of 2005, unless a resolution of this matter can be reached with the government within such timeframe. Several current and former senior level employees associated with Grace's construction products business also have been named as targets of the investigation. On November 15, 2004 the U.S. Bankruptcy Court granted Grace's request to advance legal and defense costs to the employees, subject to a reimbursement obligation if it is later determined that the employees did not meet the standards for indemnification set forth under state corporate law.

Under the Department of Justice's Principles of Federal Prosecution of Business Organizations, a company's payment of the legal fees of its employees, at least when they are not required by law to be paid by the organization, can be a basis for finding that the company did not cooperate with the federal investigation. (ph)

Last week was not a good week for some individuals associated with Fiber Materials, Inc and Materials International, Inc. That's because the First Circuit vacated a judgment of acquittal notwithstanding the verdict and reinstated defendants' convictions. The court remanded the case back to the District Court. (The court was not willing to accept the double jeopardy or vagueness arguments of the defendants.)

In United States v. Lachman, the court was interpreting an Export Administration Act regulation that used the term "specifically designed." The court decided that this term should be interpreted by looking at the text and purpose of the statute. The court rejected, and admits to rejecting, a rule of statutory construction that looks at "identical words used in different parts of the same act."

The Export Administration Act provides the Commerce Department with authority over the export of goods and technology for commercial use, and also over items with a dual purpose use of both commercial or military. The Act's congressional findings emphasize the need to balance international commerce and national security. My guess is that national security will have the winning argument in most cases these days and that attorneys representing corporations handling dual purpose items should be especially careful.

(esp)

[Editor's note: This posting has been corrected by deleting a sentence which stated that the First Circuit did not consider the Rule of Lenity in reaching its decision. The opinion states in a brief footnote that the rule is not relevant to its analysis. Thanks to Michael Zara of Bryan Cave LLP for pointing out the error in the original post.]

Toughening up on corporate crime is not unique to the United States. Scotland is planning a corporate homicide law. BBC News reports that "[p]lans have been announced for a specific offence for corporate and public bodies which cause death through failures of management." The law is a reaction to the fact that "[i]n June 2003, appeal court judges in Edinburgh rejected a charge of culpable homicide brought against the gas pipeline firm, Transco, following the death of a family-of-four in Larkhall."

Some may recall how the U.S. tried a homicide charge, unsuccessfully, in the Ford Pinto Case. Corporate homicide charges remain a controversial topic in the U.S. today. Check out a 2003 column called "Corporate Homicide," by Russell Mokhiber and Robert Weissman.

Speaking out about the federalization of criminal law is the American Bar Association, that assembled a commission to study the issue (headed by Edwin Meese III) and in 1998 issued a report that stated that "[a]lthough it may be impossible to determine exactly how many federal crimes could be prosecuted today, it is clear that of all federal crimes enacted since 1865, over forty percent have been created since 1970."

But this does not seem to be stopping Congress.

Paul Rosenzweig and Trent England of the Heritage Foundation recently authored a piece titled, Horsing Around Congress, in the American Spectator. It's on one of the latest congressional considerations - the American Horse Slaughter Prevention Act. As they state, " [f]or some reason, in the midst of the war on terrorism and debates about the economy and Social Security, Congress is trying to criminalize horsemeat."

Martha, who CNN notes is ranked as someone people wish to sit next to on a long plane flight (ranked just behind Bill Gates), issued a Thanksgiving message on her website. Included in the message, that thanks all her supporters, she lets us know that she has been informed that her website has " 8 million hits since" she began serving her sentence, not to mention the thousands of emails. If the aim of the government is general deterrence through this prosecution, then one has to wonder if they made the correct prosecutorial choice here.

In the meantime, CNN reports that the government filed yesterday a 220 page response brief in the Second Circuit. The appellate brief filed by her attorneys is located in our November 3, 2004 entry.

I thought I had seen all the white collar crime books written, but just heard about a new one. Yes, an encyclopedia - "The Encyclopedia of White Collar and Corporate Crime." It's written by Lawrence M. Salinger and published by Sage Publications and looking at the introduction it appears to be a social science work. It states in the intro that "[t]he articles have been written primarily for the college library, public library, and high school library readers. Post-graduate academics and law firms may find the reference useful to add to their libraries."

AIG and its subsidiary AIG Financial Products Corp. (AIGFP) have submitted an offer of settlement to the Staff of the Securities and Exchange Commission (SEC) that the Staff has agreed to recommend to the SEC, and reached agreement in principle with the U.S. Department of Justice, with respect to issues arising from certain structured transactions with The PNC Financial Services Group, Brightpoint, Inc., and related matters. Final settlement is subject to approval by the Securities and Exchange Commission, the Department of Justice, and the United States District Court.

A report in the Wall Street Journal (Nov. 24) describes the insurance products that AIG sold to companies to help "smooth" their earnings that is the subject of the civil and criminal actions. The purchasers, Brightpoint Inc. and PNC Financial Services, used the insurance to spread losses over a longer period of time (Brightpoint) and remove underperforming loans and investments off the company's balance sheet (PNC). According to the Journal:

The probes involve two very different financial products, with an element in common, according to regulators: They were aimed at helping the buyers hide adverse financial developments from their shareholders. One of the products was an alleged bogus insurance policy that in reality was little more than a loan, regulators have maintained. This allegedly sham policy allowed Brightpoint Inc., a Plainfield, Ind., cellphone distributor, to spread a large quarterly loss from a United Kingdom trading unit into future periods by using the more-favorable accounting treatment that insurance allows.

The other was an off-balance-sheet investment vehicle, into which Pittsburgh-based PNC Financial Services Group Inc. allegedly stuffed $762 million of underperforming loans and venture-capital investments, avoiding write-down charges, regulators have said.

What does it cost to enter into a global settlement with the government? According to the Journal:

People familiar with the matter said the pact could obligate the company to an independent review of its past transactions with other customers, a move regulators have sought as part of a widening campaign to crack down on companies' use of financial engineering to manipulate their earnings results.

Another person familiar with the discussion said the cost of the SEC portion of the settlement to American International Group would be between $60 million and $90 million. At the high end, such a penalty would rank among the largest paid by any of the financial-services firms that have come under scrutiny for allegedly helping clients cook their books. Under the tentative SEC pact, the agency would file civil securities-fraud charges against AIG, which would neither admit nor deny wrongdoing, according to one of the knowledgeable people.

The settlement only covers the federal government, and does not resolve the various private law suits by shareholders and securities purchasers. That will add to the final tab for AIG. Another interesting question is whether Maurice Greenberg, AIG's long-time CEO and Chairman, will last much longer in his position. Greenberg's son, Jeffrey, was forced out as CEO of Marsh & McLennan last month shortly after New York Attorney General Eliot Spitzer sued the company for bid-rigging in the insurance brokerage industry. (ph)

An article in the Washington Post (Nov. 23) discusses the recent push to investigate the conduct of lawyers for corporations who assist their clients in wrongdoing. Defense lawyers have complained that the authority granted to the SEC in the Sarbanes-Oxley Act to discipline lawyers will be used to chill proper legal representation. Apparently, the complaint is falling on deaf ears at the SEC:

Responding to complaints from defense lawyers at yesterday's American Bar Association meeting that the agency was moving too aggressively, deputy enforcement director Linda Chatman Thomsen said, "I'm delighted that you're all worried. It's part of the job."

As Sgt. Phil Esterhaus used to intone at the end of roll call on Hill Street Blues: "Let's be careful out there."

Frank Quattrone, former star high tech investment banker at Credit Suisse First Boston (CSFB), was permanently barred from the securities industry and fined $30,000 by the NASD yesterday (Nov. 22). Quattrone was convicted this past March of obstruction of justice in connection with an e-mail he forwarded to others in his group about cleaning up their files while the SEC was conducting an investigation of CSFB's activities in the IPO market, particularly those of Quattrone's high tech investment group. He was sentenced to 18 months imprisonment, and is currently free on bail pending appeal.

The basis for the NASD's permanent bar is that Quattrone refused to testify on the record before an NASD hearing panel investigating his conduct. Quattrone asserted his Fifth Amendment privilege, but the NASD refused to recognize such a right for a member of the securities industry subject to its regulations because the Fifth Amendment only applies to the government and not private organizations. The NASD's news release states:

At his attorneys’ request, NASD Enforcement agreed to postpone Quattrone’s testimony and to take that testimony near Quattrone’s home in San Francisco because of issues concerning Quattrone’s health. But ultimately, Quattrone’s attorneys informed NASD Enforcement that he declined to testify in any location, because of pending state and federal investigations into the same misconduct. In March 2003, NASD Enforcement charged Quattrone with violating NASD conduct rules by refusing to testify. Quattrone answered the charges by denying any wrongdoing; arguing that because of ongoing criminal investigations into the same misconduct, the Fifth Amendment prevented NASD from compelling him to testify, and asserting that by trying to force him to waive his constitutional right against self-incrimination, NASD violated its statutory duty to provide him with a fair opportunity to defend himself.

NASD’s NAC [National Adjudicatory Council] rejected Quattrone’s Fifth Amendment privilege arguments, saying the Fifth Amendment “restricts only governmental conduct,” and NASD’s function as a regulator of the securities industry does not constitute government conduct. “NASD is incorporated as a private corporation, it does not receive state or federal funding, and its Board of Governors is not composed of government officials or appointed by a government official or agency,” the NAC says in its ruling.

The NAC also rejected Quattrone’s argument that NASD Enforcement failed to provide him with a fair opportunity to defend himself. To the contrary, it found that NASD Enforcement satisfied its statutory obligation and provided Quattrone with the procedural safeguards required by the federal securities laws.

“Enforcement made written requests for Quattrone’s on-the-record testimony… Pursuant to Quattrone’s request, the testimony was rescheduled and relocated,” the NAC’s ruling says. “Enforcement’s written requests for testimony stated that if Quattrone failed to comply, NASD could take disciplinary action against him that could result in sanctions, including a suspension or a bar from the securities industry. Quattrone was represented by counsel at all times, and he made a fully informed choice to refuse to provide testimony to NASD…”

The original hearing panel recommended only a one-year bar, but the NAC increased that to a permanent bar because it found that Quattrone's conduct was "egregious." Quattrone's attorney stated that he would appeal to the SEC.

The sanction against Quattrone highlights a problem for anyone working in an industry subject to self-regulation by a private body. The NASD's regulations are subject to review and approval by the SEC, and its decisions are subject to SEC review, but courts have held consistently that it is a private body and therefore the Fifth Amendment privilege against self-incrimination does not apply to its proceedings (see, e.g. D.L. Cromwell Investments, Inc. v. NASD Regulation, Inc., 132 F.Supp.2d 248 (S.D.N.Y. 2001), aff'd 279 F.3d 155 (2d Cir. 2002)). Our casebook (White Collar Crime: Law and Practice (2d ed.)) highlights the parallel proceeding problem that confronts every defendant whose conduct is subject to both criminal and civil regulation--which seems to be just about everyone these days. Quattrone was called to testify while the grand jury was investigating his conduct, and almost every attorney would recommend that a client not testify while such an investigation was in progress, much less after an indictment is returned. This is a true Hobson's choice, and one which does exact a penalty from the person who refuses to cooperate with an industry or licensing investigation. (ph)

An earlier post (Nov. 17) discussed the government's investigation of Boeing and the guilty pleas of two former executives, one of whom had been a senior Air Force official, for negotiating employment while the official worked on a contract awarded to Boeing. The Air Force's favorable treatment of Boeing has created a very significant enemy for the company: Senator John McCain (R-Arizona). On Friday, November 19, Senator McCain released a statement in the Congressional Record detailing the Air Force's favoritism toward Boeing and its attacks on the company's main rival, Airbus. Two days before the Senator released his statement, Secretary of the Air Force James Roche and Assistant Secretary of the Air Force for Acquisitions Marvin Sambur announced their resignations. Both were prominent proponents of Boeing.

Along the way, Boeing also appears to have orchestrated a campaign against Senator McCain, who strongly opposed the award of a multi-billion dollar contract for Boeing to lease plane to the Air Force. Senator McCain's statement includes the following:

Throughout 2002 and the beginning of 2003, even agencies within the Defense Department and the Air Force, including Program, Analysis and Evaluation; the Office of Management and Budget; and even the Air Force’s own General Counsel’s Office, raised salient concerns about aspects of the proposal. These concerns, however, would not get in the way of Air Force leadership. Rather than resolve these concerns, Air Force proponents continued to aggressively push the deal in the press. A Wall Street Journal editorial, entitled “John McCain’s Flying Circus,” published on the very same day as my tanker hearing in the Commerce Committee, is particularly notable. It was obviously drafted with considerable help from the Office of Air Force Secretary. In it, tanker proponents accused me of “trying to prevent approval by running up my own Jolly Roger” and brazenly exaggerated the Air Force’s need for tankers by describing how, during Secretary Roche’s visit to Tinker Air Force Base, he “peeled back the skin of a tanker being refurbished and found the metal underneath disintegrating before his very eyes.”

By this time, Air Force leadership’s aggressive press campaign was well underway. On April 25, 2002, Secretary Roche’s special assistant William Bodie told Secretary Roche that he “saw Rudy deLeon [who heads Boeing’s Washington Office] at the Kennedy Ctr and politely asked the Great White Arab Tribe of the North [which is what these folks called Boeing] to unleash their falcons on our behalf for once. And, I talked to [defense analyst] Loren [Thompson], who is standing by to comment to this reporter about the national security imperatives of tanker modernization. [Editor of Defense News and Air Force Times] Vago [Muradian] is also standing by. I will get with [Assistant Air Force Secretary for Acquisitions Marvin] sambur first thing to rehearse talking points. We will get with you before we talk to the reporter.”

The Senator also released e-mails from Secretary Roche showing how he favored Boeing over Airbus:

Secretary Roche’s e-mails, however, suggests that he is indeed a man who allows his personal animus to stifle competition. For example, on September 5, 2002, Darleen Druyun wrote to Secretary Roche, “I read with disgust the article on Airbus tankers from the new EADS CEO of North America. What BS ... should not have been surprised at the slime ... his day of reckoning will come hopefully.”

Secretary Roche answered, “Oy. I agree. I had hoped you would have stayed and tortured him slowly over the next few years until EADS got rid of him!” This, from a person who testified that he “believes” in competition. Secretary Roche’s personal contempt for one defense contractor and, in particular, its CEO, is clearly reflected in his other e-mails. For example, on August 7, 2002, when Secretary Roche learned that Ralph Crosby, with whom Secretary Roche once worked at Northrop Grumman, was appointed to head EADS’ North American operations, Secretary Roche wrote to his special assistant William Bodie, “Well, well. We will have fun with Airbus.”

The day after, William Swanson at Raytheon asked Secretary Roche, “Did you see the notice on Ralph and EADS?” Secretary Roche responded: “Right. Privately between us: Go Boeing! The fools in Paris and Berlin never did their homework. And, Ralphie is the CEO and Chairman of a marketing firm, for that’s all there is to EADS, North America. The [Air Force] has problems with EADS on a number of levels. The widespread feelings about Crosby in the Air Staff, Jumper especially, will only make their life more difficult. Smiles.”

Senator McCain is not the type of enemy a company that does extensive business with the Pentagon wants to make. (ph)

A recent decision by U.S. District Judge Harold Baer, Jr. on the availability of the work product protection for an internal investigation report shows the difficulty corporations face after the Sarbanes-Oxley Act and the heightened pressure on them to cooperate in government investigations. In Merrill Lynch & Co. v. Allegheny Energy Inc., No. 02 Civ. 7689 (S.D.N.Y. Oct. 26, 2004) [Westlaw citation 2004 WL 2389822], the court considered the following:

Allegheny also seeks production of two reports, which are the results of Merrill Lynch's internal investigation into the circumstances surrounding [Robert] Gordon's theft of some $43 million in connection with the Falcon Energy Trade. In the Fall of 2002, shortly after this lawsuit was filed, the United States Attorney's Office for the Southern District of New York informed Merrill Lynch that it was investigating the Falcon Energy Trade. Merrill Lynch therefore undertook its own internal investigation (conducted by and under the supervision of in-house and outside counsel), which culminated in two reports . . . .

When Merrill Lynch's internal investigation was disclosed, the company's outside auditor, Deloitte & Touche, requested and received copies of the internal report. Allegheny Energy based is discovery request for the report on the ground that disclosure to Deloitte & Touche constituted a waiver of the attorney-client privilege--which Merrill Lynch conceded--and the work product protection. The court rejected the claim, stating:

[C]ourts are split in their treatment of disclosures to a corporation's accountants or auditors. More precisely, courts differ in their conceptualization of two critical points that are often implicitly intertwined in their analysis: whether the "adversary" contemplated by the work product privilege is necessarily a litigation adversary and whether a corporation's auditor is such an adversary, to whom disclosure will waive the privilege. While admittedly there are good arguments on both sides, in this case, I answer both questions in the negative and conclude that Merrill Lynch's disclosure of the reports to Deloitte & Touche did not constitute a waiver of the applicable work product protection.

This is a close question, as Judge Baer states, and presents an issue that will be of continuing concern to corporations. The Sarbanes-Oxley Act imposes increased duties on accountants to discover and report fraud and certify that a company's internal controls are adequate to prevent misconduct. Therefore, they will demand access to internal investigative reports in order to determine the sufficiency of the company's internal controls and to assure that there is no deeper misconduct. Similarly, under the Department of Justice's Principles of Federal Prosecution of Business Organizations there is a strong incentive for corporation's to cooperate in federal criminal investigations by conducting an internal investigation and providing the results of that to the government by waiving the attorney-client privilege and work product protection. The risk of any disclosure of the internal report is the loss of any protection from discovery requests of third parties, especially in shareholder and securities lawsuits. Whether Judge Baer's opinion becomes the norm, at least with regard to providing reports to accountants, will no doubt be tested in future cases. (ph)

One of the more controversial provisions of the Sarbanes-Oxley Act of 2002 was Section 307, which required the SEC to adopt rules requiring lawyers for corporations to report misconduct within the organization to senior management and the board of directors. An implementing rule, since shelved, would have required lawyers to make a so-called "noisy withdrawal" if the corporate client did not respond appropriately to the report of misconduct. Lawyers objected to this rule on the ground that it would make corporate counsel a "cop on the beat" rather than a representative of the client. Regardless of whether that would in fact be the case, Section 307 emphasizes that corporate counsel has a responsibility to protect the client from misconduct by, at a minimum, reporting wrongdoing and, where necessary, withdrawing from representation.

Although it is always hard to tell whether a law has an effect on individual conduct in a particular instance, a story in the New York Times (Nov. 21) by Partick McGeehan (one of their best business reporters) details the fight between TV Azteca, a Mexican media company whose shares are listed on the New York Stock Exchange and hence subject to SEC regulation, and its former lawyers who withdrew from representation because the company refused to make the proper disclosure of a transaction. The article discusses a draft investigative report prepared by Munger, Tolles & Olson, which was hired by independent directors to investigate the dispute between Akin, Gump and management when the company refused to disclose a transaction between TV Azteca's chairman (Ricardo B. Salinas Pliego) and the company that appears to have provided a personal benefit of $109 million. The company refused to make the disclosure, and Akin Gump resigned as its counsel. According to the investigative report, the company then sought a favorable opinion about not having to disclose the transaction from Clearly, Gottlieb and Hogan & Hartson, both of which counseled disclosing the transaction. The Munger Tolles report alleges that corporate management provided false information about the transaction to the firm in conducting its internal investigation.

The article reports:

Two American directors, James R. Jones and Gene F. Jankowski, did not even wait around for the final report from Munger Tolles. They resigned in early May because they did not believe that they could exercise independence, Mr. Jones said in a brief interview last week. "Gene and I concluded that we needed to leave," said Mr. Jones, a former United States ambassador to Mexico who once ran the American Stock Exchange.

Mr. Jones said that he was interviewed by the commission before he resigned but that he had not been contacted since. Only four years earlier, Mr. Salinas Pliego pointed to Mr. Jones and two other directors as evidence of his enlightened embrace of changing standards of corporate governance.

Attorneys have an ethical obligation to ensure that their clients, especially corporate clients, obey the law and make proper disclosures to the investing public. While some may object to this "gatekeeping" role, it is heartening to see that one company could not "buy" an opinion. If the findings in the Munger Tolles report are accurate, one would hope the SEC would bring an enforcement action against the company to reinforce the signal that improper disclosure and attempts to buy a favorable legal opinion are unacceptable. (ph)

What did it take to get a non-guilty verdict in the Enron Barge Trial?

Yes, of course it helps to be innocent of crimes charged, but sometimes that just isn't enough.

In a fascinating article in the Texas Lawyer titled, "Enron Defendant Worked Alongside Attorneys to Win Acquittal," one hears the story of former Enron Corp. employee Sheila K. Kahanek who was recently acquitted in the Enron Barge Trial. The article tells how she assisted her attorney by reviewing and analyzing all of the government documents in the case. The article even includes a post-trial email from a juror to her attorney, Dan L. Cogdell. She did such a good job assisting her attorney that it now looks like her future may be in trial consulting in white collar cases.